Leasing

Definition

Leasing basically consists of a special lease-financing contract that allows the user to have a productive capital good, chosen with absolute freedom and according to their needs, during the agreed term, by paying regular instalments, normally monthly, which include the cost of the equipment plus the corresponding interest.

During the term of the contract, the leasing company owns the good.

The user must allocate goods subject to assignment only to their economic activity. Only productive capital goods can be financed.

At the end of the contract term, the client can freely choose between the following three options:

• To buy the equipment for a price previously established when signing the contract, which is called residual value.
• To sign a new leasing contract and continue using the good for a new period by paying much lower instalments than those of the first period, calculated on the residual value.
• To return the equipment to the leasing company.

Types of leasing

Real estate or chattel leasing:

• Real estate leasing is one whose purpose is a business premises or industrial warehouse, and chattel leasing is one established on capital goods.
• The real estate must necessarily be considered business premises, that is, they cannot be financed by leasing homes for private use.
• The minimum term is normaly established by law. For instance, in Spain is ten years in the case of real estate leasing and two years in chattel leasing.
• Another difference lies in the percentage that the residual value represents in each of the transactions: In general, 15% is used for real estate (non-depreciable land value) and the amount of an instalment for real estate leasing.

Operating and financial leasing:

• Operating leasing, comparable to renting, is that carried out by the supplier himself, usually establishing a maintenance contract for the good, and the residual value being the purchase price of the equipment. It usually has a term of between one and three years and the lessee can return the leased good at the end of the contract, or acquire the good for its residual value. The good does not appear on the assets of the lessee company’s balance sheet, since it is not part of its fixed assets. In this type of contract are involved the supplier or manufacturer and a lessee.
• Financial leasing differs from the previous one in that the supplier is a financial intermediary, usually a leasing company, and the residual value generally being equal to the amount of an instalment. It allows acquiring (at the end of the contract) the good chosen by the company by paying the residual value showed in the contract, and that, generally, coincides with the amount of a monthly instalment. This is the usual type of leasing, also known as finance lease.

Vehicle leasing:

• When it comes to an industrial vehicle (truck, van, etc.) there is no doubt about its use for the productive activity of the company. However, private cars can have a double function, that is, they are goods necessary for receiving income or they are consumer goods.
• Current legislation. For example in Spain does not establish any prohibition for car leasing, as long as the client justifies their professional status and the vehicle is used exclusively for professional or business activities.

Leaseback:

• In this type of transaction, the lessee and the supplier of the machinery or the real property are the same person.
• The supplier sells the good to the leasing company, who simultaneously concludes a financial lease agreement related to such good with the customer.
• This type of transactions, together with all the traditional advantages of leasing, presents that of providing liquidity to the financial lessee, since they would receive the pre-established amount in the sale.

Advantages of leasing

For the lessee:

• Accelerated depreciation: Leasing allows the investment to be depreciated for tax purposes in a period shorter than that set by current legislation.
• They finance 100% of the investment.
• Full freedom to choose the manufacturer and model of equipment that best meets your needs.
• From a tax perspective, instalments paid for leasing are considered a deductible expense for corporation tax and income tax purposes, within the legal limits.

For the supplier:

• It frees up financial resources, since the leasing company is the one who finances your sales, which allows them to collect them in cash.
• It reduces the default risk, since the leasing company pays them.

General characteristics of financial leasing (example based in Spanish legislation)

• Purpose: Availability and eventually acquisition of fixed assets.
• Term:
  • Chattel: Minimum 2 years.
  • Real estate: Minimum 10 years.
• Amount: Covers the entire cost of the good (except in the case of vehicles, in which it does not cover taxes and registration expenses; and in the case of real estate, in which it does not cover taxes and deed execution expenses).
• Instalments: They comprise two concepts:
  • Recovery of the cost of the good.
  • Interests.

In addition, since it is formally a lease, VAT is added on the base amount of the instalment.

• Payment: Instalments are prepayable, that is, they are paid in advance, at the beginning of each agreed period.
• Amortization: The repayment schedule is similar to that of a loan with periodic instalments, with the particularity of the input VAT.
• Residual value (option to purchase the good): Equivalent to the amount of an instalment.
• Guarantee: The main guarantee is the good itself, whose ownership or retention of title belongs to the financial institution. Additional collateral (e.g. sureties) may be requested as in other asset-side transactions.
• Formalization: Usually a leasing agreement.

Differences between leasing, conventional lease and loan

In practice, leasing is a way of acquiring a property gradually through the payment of periodic instalments that include the cost of the property and the interest received by the financial institution. On the contrary, the conventional lease does not contemplate the acquisition of the property or, if it does, it is for a high price.

On the other hand, both the loan and the leasing follow a similar repayment plan; the loan is originated by the purchase of a property that the company owns from the first moment. Another important difference is the favourable tax treatment that the leasing has with respect to the loan.

Interest and commissions of a leasing transaction

When taking out a leasing, you have to take into account the associated costs:

• Ordinary interests (fixed or variable).
• Interest on late payment.
• Origination and arrangement fees.
• Commissions for modifying conditions and guarantees, for claiming overdue positions, for partial or total redemption, for direct debit of the receipts in another institution and for non-payment of those receipts.
• Notary fees.